Health care providers quickly went from hero to zero in the fourth quarter of 2018 after a failed breakout and bearish momentum divergence, but we're beginning to see signs of a potential mean reversion over the short term.
Let's start with health care relative to the S&P 500 – represented by the Health Care Select Sector SPDR Fund (XLV) vs. the SPDR S&P 500 ETF (SPY) – which has been unable to find its footing since topping five months ago. Prices have now retraced 61.8% of their 2018 rally, which may offer some short-term support and transition the trend from down to sideways.
The weakest subsector within health care has been health care providers, represented by the iShares U.S. Health Care Providers ETF (IHF). However, a ratio of IHF to XLV recently confirmed a bullish momentum divergence and failed breakdown by closing back above 1.85. As long as prices are above that level, our risk is well defined on the long side for a countertrend move back toward 2.00 to 2.04.
There's a similar setup brewing in the ratio of this subsector versus the S&P 500, but it needs to close above 0.601 for confirmation. Similar to IHF/XLV, there's potential for a roughly 10% rally back toward its 200-day moving average if these conditions are confirmed by price.
There's been no reason to bottom fish this subsector over the past five months, but these signs are suggesting that a mean reversion is likely in the near term. Our risk is well defined on the long side, and the reward/risk is skewed in our favor, so whether you trade these pairs directly or play the theme through individual names, it's worth paying attention.
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